‘What’s The Worst That Can Happen’? Pandora’s Box And The ‘Balkanisation’ Of Spain

Ok, so here we are, the day after a brutal (and seemingly disproportionate) crackdown in Spain, where the government decided to prove how unassailable the country’s democracy is by shooting secessionists with rubber bullets.

European markets took things in stride, unless you count… well… unless you count the IBEX, which fell sharply:

Spanish yields rose as well as markets are again starting to price in breakup risk – albeit knowing full well that Draghi will “do whatever it takes” with PSPP:

This morning, regional leaders in Catalonia said they intend to declare independence within a week after 89% voted “yes”. Madrid is having none of it:

#BREAKING Madrid will do 'everything within the law' to stop Catalan independence declaration: minister

We remain convinced secession will not happen, at least not in the short term and not unilaterally. Indeed, as the events of yesterday showed, the Spanish government will never allow it. There are at least three reasons for this: 1) according to the Spanish constitution, Spain is indivisible; 2) without Catalonia, Spain would not be the same, with the Spanish government reiterating that 7 million people cannot decide the future of 39 million; 3) allowing independence would be opening Pandora’s box, with independence movements in other parts of Spain possibly seeking to organise a self-determination vote and the inherent risk of a complete ‘Balkanisation’ of Spain (so to speak).

The international community is also highly unlikely to recognise unilateral secession, as territorial unity and indivisibility is universally accepted. On top of that, even the legality and validity of the Law of referendum has been called into question: only adopted with a simple majority (instead of a two-third one for law reforming the Statute of Autonomy or new electoral law), change in law happened less than a month before the vote, the lack of minimum participation rate…

More specifically, the EU would not recognise Catalonia as an independent state, as long as such a move is considered in violation of the Spanish constitution. Moreover, the EU would also want to avoid a probable domino effect, given the existing secessionist movements across Europe.

So what’s the worst that could happen?

Well, that’s a question worth exploring and Bloomberg’s Paul Dobson is going to do just that in the piece excerpted below…

Via Bloomberg

It’s worth asking exactly what are the risks emanating from the Catalan questionand why are markets suddenly surprised by it today when we’ve known it was coming for weeks? Some thoughts:

The way the police, under instruction from Rajoy, responded to what was a peaceful protest appeared heavy-handed and caught the attention of the global media — even though the Spanish leader can argue that he acted because the constitutional court had found the referendum to be unlawful.

There’s a near-term risk that the discontent rises and results in strikes and protests that disrupt economic activity or knock national confidence. That’d be a blow when things are looking rosier — see today’s beat on the manufacturing PMI as evidence.

The standoff could also escalate if Catalonia declares independence and/or the central government strips the region of its autonomy.

Could Rajoy’s leadership be vulnerable? If he loses support in parliament, there’s an outside chance that this could topple the government and create unexpected political risks.

Given all the progress that has been made on the euro project, it’s unlikely investors hark back immediately to the debt crisis. After an initial spread widening, Italy’s yields have come back relative to Germany, a sign investors aren’t over-worried about contagion (and Italy’s upcoming election) as a result of this.

The Spanish- German yield spread is within last week’s trading range, a sign that this is far from panic in markets as yet.

But if this is a step on the path toward a possible future secession of one of Spain’s most important economic regions, it could spell a lot more trouble for the nation’s finances down the track.

It might soon be time for “Super Mario” to crank up the printing presses (some more) and perhaps think about tweaking the PSPP rules to allow for more support of periphery spreads.

Here’s a quick wrap of analyst opinions as compiled by Bloomberg:

Morgan Stanley analysts, in note:

Although the bar for secession looks pretty high, uncertainty and potential risk of destabilizing the central government will most likely drive some volatility similar to what we have seen the last few weeks. CaixaBank and Sabadell, both from Catalonia, would be the two banks most directly exposed, however this is a negative for all Spanish bank stocks.

Societe Generale equity strategists, in note:

A combination of a minority government and the Catalan independence push might prevent Spain from making much-needed reforms, hence we remain shy of Spanish equities.

SocGen lists 18 stocks exposed to Catalonia and potentially at risk on a relative basis if tensions were to rise, or that could benefit if tensions were to ease:

Any market impact from Catalonia referendum will likely be mainly felt in CDS, debt and FX markets with impact on equities smaller. The consequences could act as an ongoing background negative force on European risk assets but it is likely that markets in coming months will still put more weight on the improved growth and inflation data from the region.

Citi economists, in note:

Our baseline is for a new round of regional elections in Catalonia. While still not the most likely outcome, we believe the risk of larger confrontations in the near term is rising, involving at the extreme wide disruptions with potential severe economic costs. In the long run, as we discussed before, solving the Catalan challenge may require more fiscal autonomy for the region and possibly allowing a formal self-determination referendum. With both widely opposed by the rest of the country, a solution remains years away.

Writing about a subject is the best
way to educate yourself about it, and when I flick through past work I remember how much
they taught me, if no one else. Mainly they taught me that I didn’t know very much. But they
also taught me that most other people didn’t know much either. Thus, some key themes
which stand out include the illusory control of policy makers, the presumed knowledge of
those looking to them to actively do good, the ease with which we fool ourselves, and how
best to protect capital in the face of such unavoidable uncertainty. -- Dylan Grice